Jan. 22 (Bloomberg) -- The Canadian dollar reached the
weakest in more than four years after the Bank of Canada lowered
its inflation forecast and said the currency remains strong
enough to be a competitive challenge for the nation’s exports.

The currency extended a four-month slide versus its U.S.
peer as the central bank kept its benchmark interest rate at 1
percent, as forecast by every economist in a Bloomberg survey.
It’s been unchanged since September 2010. Bank Governor Stephen
Poloz said the direction of his next move will depend on the
economy’s evolution. He refrained from inserting language into
the bank’s statement on a need for lower interest rates.

“Everything they’ve said here so obviously welcomes the
currency going down it would be a small step from that to start
allowing the currency to drive domestic policy,” said Adam
Cole, head of Group of 10 currency strategy at Royal Bank of
Canada, by phone from London. “Even though they didn’t move to
an easing bias, it takes us a step closer to that, maybe.”

The loonie, as Canada’s currency is nicknamed for the image
of the aquatic bird on the C$1 coin, depreciated 1.1 percent to
C$1.1087 per U.S. dollar at 5 p.m. in Toronto. It touched
C$1.1092, the weakest since Sept. 2, 2009. One Canadian dollar
buys 90.20 U.S. cents.

The currency fell versus 15 of its 16 major counterparts
tracked by Bloomberg. It has dropped 4.2 percent against the
U.S. dollar in January.

‘Competitiveness Challenges’

“Despite depreciating in recent months, the Canadian
dollar remains strong and will continue to pose competitiveness
challenges for Canada’s non-commodity exports,” the bank said
in its quarterly Monetary Policy Report.

Canada’s benchmark 10-year government bonds rose, with
yields falling two basis points, or 0.02 percentage point, to
2.49 percent. The price of the 1.5 percent security maturing in
June 2023 added 13 cents to C$91.79.

The interest-rate advantage of the U.S. Treasury 10-year
note over its Canadian counterpart increased to 37 basis points,
the most since June 2009, increasing the relative allure of U.S.
securities as policy expectations in the two countries diverge.

The Federal Reserve is reducing its monetary stimulus. The
U.S. central bank has cut monthly bond buying to $75 billion,
from $85 billion, and economists in a Bloomberg survey Jan. 10
forecast it will keep tapering the purchases in $10 billion
increments at each of its policy meetings this year.

Excess Capacity

The Canadian economy still has “significant” excess
capacity and inflation is being held down by global weakness in
food prices and a recent increase in retail competition, the
Bank of Canada said. Consumer prices will advance at an average
year-over-year pace of 0.9 percent in the first quarter, below
the bank’s 1 percent-to-3 percent target band, before quickening
to 1.5 percent in the fourth quarter.

Poloz predicted that the currency’s recent weakening should
help exports.

The Canadian dollar has fallen against all of its major
peers since the end of December as Poloz has said he’s concerned
inflation is too low. It has been below the Bank of Canada’s
target band for two months, and lower than 2 percent for 19
months.

Data this week will show consumer prices for December
increased 1.3 percent on an annualized basis, according to
economists in a Bloomberg survey.

Canada’s manufacturing base has shrunk, meaning a weaker
currency will provide less of an economic spark that it would
have in the past.

‘Smart Strategy’

The rate decision has “changed everything, because
essentially they’ve told us they’re targeting a long-term
exchange rate,” said Sebastien Galy, senior currency strategist
at Societe Generale, by phone from New York. “It’s probably a
smart strategy to reset the Canadian dollar to a level that’s
compatible with the manufacturing sector.”

Poloz surprised investors in October by dropping language
from the bank’s policy statement about the need for future
interest-rate increases, citing slack in the economy. The
language had been in place for more than a year.

The Canadian currency lost 1.4 percent over the past week
in a basket of 10 developed-nation peers tracked by the
Bloomberg Correlation-Weighted Index. It was the worst
performance. The U.S. dollar gained 0.2 percent.